Securities Compliance Sentinel - Analysis of Cutting Edge Securities Industry Issues

The U.S. Court of Appeals for the Third Circuit found that two founders of a metal components business were not liable in a securities fraud lawsuit although both had improperly looted millions of dollars of corporate assets. See Gallup v. Clarion Sintered Metals Inc., 3d Cir., No. 11-4004, 7/26/12, and http://federal-circuits.vlex.com/vid/paul-gallup-clarion-sintered-metals-390620030.

Essentially, the investors had not shown reliance to prove their Securities Exchange Act of 1934 Section 10(b) claim.  However, the court did allow them to continue -- albeit in state court-- with their other claims after documenting a pretty elaborate scheme to depress the price of the stock and cover-up their fraud.  Interestingly, the court did indicate that the plaintiffs had not read any of the financial statements the company issued.  Thus, although they may have a claim for breach of fiduciary duty or improper management, those claims are not sounded in federal securities law.

Consequently, the moral of the story, if you want to sue, at the very least, keep up-to-date with the company's newsletters and financials!!

I previously wrote about how the Food and Drug Administration and Department of Justice used the responsible corporate officer doctrine to charge former Purdue Pharma executives and in-house counsel with criminal liability and career-ending debarment for “off-label” drug marketing, even though the charged parties did not personally participate in the conduct or even know about it.  Recent court activity may significantly reduce such exposure for similarly-situated individuals, with ripple effects spreading through many legal sectors, including shareholder suits.

In a game-changing decision released on December 3, 2012, the Second Circuit Court of Appeals reversed the conviction of Alfred Caronia, a pharmaceutical sales representative who had been convicted of conspiring to introduce a misbranded drug into interstate commerce.  The evidence at trial included recordings of Mr. Caronia’s statements to doctors that Xyrem, a drug that the FDA approved for narcolepsy, could also be used to treat various other conditions for which the FDA had not approved the drug.

Mr. Caronia argued that the prosecution violated his First Amendment right to free speech.  The Second Circuit agreed, and in reversing his conviction narrowly read the scope of the Food, Drug, and Cosmetic Act “as not criminalizing the simple promotion of a drug’s off-label use because such a construction would raise First Amendment concerns.”  Mr. Caronia’s conviction relied on off-label promotion, and was therefore invalid.

Depending on one’s perspective, pharmaceutical representatives promoting off-label uses for their products are either modern snake oil salesmen or critical conduits of information to medical treatment providers regarding cutting-edge therapies.  

Setting this debate aside, the Caronia decision could upend the current FDA regulatory and enforcement regime regarding off-label marketing, with wide-ranging effects.  In addition to the government’s revitalization of the responsible corporate officer doctrine, recent years have witnessed:  (1) the government attempt to prosecute in-house counsel for obstructing an off-label marketing investigation; (2) the government require, in settlement of misbranding charges, corporate integrity agreements that prohibit compensation of the sales force based on sales goals; and (3) scores of whistleblower lawsuits, False Claims Act actions, and the follow-on class-action shareholder lawsuits involving off-label marketing.

This could all change if the Supreme Court affirms the Second Circuit or if other appellate courts agree that prosecutions for “off label” marketing violate free speech rights.

In response to the Supreme Court’s decision in Morrison v. National Australia Bank where the Supreme Court said that there was no private right of action for lawsuits that involved transnational fraud, the SEC has taken a position that has angered some. 

As many know, the Dodd-Frank Act confirmed the SEC's jurisdiction as it relates to potential foreign involvement.  However, the SEC was not so quick to support such a stance for private litigants.  In particular, the SEC believes that Congress could either clarify the Morrison test or take no action.

This no action position has engendered much criticism from SEC Commissioner Aguilar.  Commissioner Aguilar believes that Congress should revert to the pre Morrison test of conduct and effect, and ignore the Supreme Court’s s decision.

Accordingly, it will be interesting to see if Congress responds to this recommendation from the SEC, since it required the SEC , through the Dodd-Frank Act, to conduct this study and make this report to Congress. 

In an intriguing case out of the United States District Court for the Western District of Missouri, a plaintiff’s purchase of condominium units with an option to participate in the rental program did not involve an investment contract under either the federal or Missouri securities laws.  The court, thus, dismissed the plaintiff’s securities claims. 

The court believed that the purchases of these condos with rental options did not rise to the level of an investment contract requiring adherence to the securities laws.  In particular, the court considered if the transaction qualified as an investment contract, analyzing if there was an investment of money, common enterprise, and the reasonable expectation of profits to be derived from the efforts of others, among others things.  The court focused on the uncertainties of both vertical and horizontal commonality required under the common enterprise element test.  In determining that there was a lack of horizontal commonality, the court found that the plaintiffs were not sold securities.  The court also noted that there was no requirement to participate in the rental program as well.

As such, this interesting case has effects in both the real estate and securities markets that have suffered greatly during the recession.  This decision may lead to an increased use of these types of programs.

Late last week, one of my colleagues sent me an e-mail where he copied 8 other people, half of them I could not identify if my life depended upon it.  I then heard about the person who had a Twitter account with over 17,000 follwers, and was now being sued by his former employer over ownership of the account-- really, does anyone think the person knows 17,000 people?  Firms and persons working in financial services industries generate trillions of e-mails every year, encompassing the mundane to the critical. 

These firms and their employees also seem to be involved in numerous civil, regulatory and criminal investigations and litigations.  Much of the vast amount of money in legal fees paid to defend these firms and their employees (sums that sometimes greatly exceed the GDP of several developing countries) often relate to e-mail review and production.  General counsels and firm management looking for ways to save money on these bills should, initially, read my article that was published in the New Jersey Law Journal, outlining the "CC" problem and ways of clamping down on this terrible plague afflicting our society, http://www.foxrothschild.com/newspubs/newspubsArticle.aspx?id=4294970187.

Once read, please do your part in stopping this madness because the dollar you save maybe your own!!

If you had asked me yesterday whether there were a lot of securities lawsuits last year, I would have said, "Oh, absolutely."  And I would have been absolutely wrong.  Lawsuits were up in 2011 compared to 2010, but still below the recent average.  As the NYTimes reports, according to a new report by Stanford Law and Cornerstone Research, "188 federal securities class-action suits were filed last year, compared with 176 filed the prior year. Even then, that figure trails the annual average of 194 filings for the period from 1997 to 2010." 

I'm guilty of what Daniel Kahneman calls "WYSIATI" (What You See Is All There Is).  First off, I (and you too) only see what gets reported, like the new crop of lawsuits related to Chinese reverse-mergers.  Obviously, we don't see what doesn't get reported, i.e. the not-filed lawsuits.  Moreover, now that this kind of thing is my job, I'm way more sensitive to reports about securities lawsuits (unlike most normal people, I won't skip an article with a headline like "Corporation's MD&A in 10-K sparks 10b-5 Claim").  This is the same little tick in our thinking that makes a teenager's parents overreact to news stories about the latest drug and/or sex fad sweeping the nation.  Already sensitive to a particular danger, a news report (especially a sensationalist one) about an isolated incident sticks in our minds and makes us overestimate the size of the danger. 

This study only measured the number of fraud claims, so there are still a bunch of other securities-related lawsuits that aren't counted here.  That said, the takeaway remains that lawsuits remained steady because the IPO and merger markets remained soft last year.  That, OR the securities industry was just way more honest last year.  I'll let you decide which theory sounds better.

Thought you might be interested in a recent podcast I did concerning my securities law practice.  http://web.me.com/cordpar/Client_Development_Tips/Law_Consulting_Coaching_Podcast/Entries/2011/10/28_Developing_a_Securities%2C_White_Collar_and_Complex_Litigation_Practice.html

If you are a securities litigator, you have heard of the Janus Capital case by now.  In that case, the United States Supreme Court took a restrictive view of securities fraud under Rule 10b-5 and held that only a person who makes a statement within the meaning of the Rule can be held liable.  The Janus Capital Court held that the maker of a statement is the person or entity with authority over the statement, including its content and whether and how to communicate it.  “Without control, a person or entity can merely suggest what to say, not make a statement in its own right.”  Janus Capital Group v. First Derivative Traders, 131 S.Ct. 2296, 2302 (2011).  The Court explained its holding by analogizing to the relationship between a speechwriter and a speaker – the speechwriter writes the drafts but the content is entirely within the control of the speaker.  As a result, the Supreme Court dismissed the Section 10b and Rule 10b-5 claim against an investment advisor that drafted the allegedly fraudulent prospectus because the investment fund had the ultimate authority over the contents of the prospectus. 

Recently, however, two District Courts have limited the impact of Janus Capital by holding that officers and directors could be held individually liable for statements made when acting on behalf of the corporation.  In In Re Merck & Co., a case arising out of the Vioxx litigation, the United States District Court for the District of New Jersey held that an officer of Merck, who signed SEC forms and was quoted in articles and reports, could be held liable for a Rule 10b-5 claim because the officer, not the corporation, had “ultimate authority over the statement.”  In Re Merck & Co., 2011 WL 3444199 (D.N.J. Aug. 8, 2011).  Similarly, the District Court in Northern District of Alabama upheld liability for corporate officers on the grounds that unlike the separate legal entities in Janus, the defendants did have ultimate authority over their statements.  See Local 703 v. Regions Fin. Corp., 2011 U.S. Dist. LEXIS 93873, at *2-3 (N.D. Ala. Aug. 23, 2011).

Some defense counsel may use the Janus Capital decision to argue that individual officers or directors can no longer by liable for Rule 10b-5 claims because the maker of the statements is always the corporation, not the individual officer or director.  The In Re Merck Court, however, takes the exact opposite view – that the maker of the statement is the officer and/or director, and not the corporation.  If that view is adopted, than perhaps the corporate entities can no longer be held liable. 

We will get a clearer view of the scope of the Janus Capital decision after the lowers courts have had an opportunity to digest and analyze the decision.